Protecting Your Business With a Self-Insured Retention

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Image courtesy of [Anthony Bradshaw] / Getty Images.

One self-insurance mechanism often used by businesses is a self-insured retention. A self-insured retention (SIR) can be used in conjunction with a general liability, auto liability, or workers compensation policy. The retention represents the amount of risk, in monetary terms, that a business has elected to retain. A self-insured retention can be an effective way to save money on insurance premiums.

This article will explain how it works.

Risk Retention

A business elects a self-insured retention when it has chosen to retain some risks. The business decides the amount and types of risk it wants to retain. It then creates a fund to pay losses that result from those risks. Here is an example.

The Heavenly Hotel is a large hotel in an area frequented by tourists. The hotel incurs a number of liability claims each year. Many are filed by guests who have sustained injuries in slip-and-fall accidents. Most of the claims have been small but a few have exceeded $50,000. 

The Heavenly Hotel is insured under a general liability policy that has a $1 million Each Occurrence limit. The hotel has elected to retain some of the risk of liability claims in order to reduce the cost of its liability insurance. Thus, Heavenly's liability policy includes a $100,000 self-insured retention. The firm has created a fund to pay liability claims.

If a claim occurs, Heavenly must pay damages up to the $100,000 retention amount. If the damages exceed $100,000, Heavenly's liability insurer will pay the remaining amount, up to the $1 million policy limit.

State Laws

States may limit the use of a self-insured retention as a replacement for certain types of insurance.

  For instance, many states may prohibit businesses from using a SIR in place of auto liability insurance unless they meet certain requirements. Some states permit the use of a SIR only if the business owns a specified number of autos (such as 25). The business may also be required to provide evidence of financial security (such as cash or a certificate of deposit) and to purchase excess auto liability insurance.

Many, but not all, states permit employers to self-insure a portion of their workers compensation obligation via a deductible or SIR. To utilize self-insurance, an employer must obtain a self-insurance certificate from the state workers compensation authority.  Many states require the employer to purchase excess workers compensation insurance. The excess insurer will require the employer to provide evidence of financial security, such as a surety bond or letter of credit. A letter of credit is issued by a bank. It ensures that funds, which the employer has deposited at the bank, will be available to pay claims even if the employer becomes bankrupt.

A self-insured retention can be an important part of an employer's risk management plan. However, it is typically available only to mid-sized or large employers. Small employers don't have the financial capacity to pay large losses out of pocket.

How It Works

Here's how a self-insured retention typically works:

  • You will need to evaluate your firm's liability risks and determine the maximum amount of loss it can sustain. This amount will become your SIR. For example, suppose that your SIR is $1 million, and your company sustains $870,000 loss. Your firm will pay the entire loss. Your insurer will pay nothing since the loss is less than your SIR.
  • Your business will create a fund to pay all losses that are less than the SIR. Your fund must be adequate to absorb all claims you accumulate during the policy period. You must estimate the maximum amount of losses you expect to incur during that period.
  • You must create and maintain your loss payment fund as required by law. Your funds should be held in an interest-bearing account.
  • A SIR may include damages only, or it may include both damages and claims expenses. If your SIR includes claims expenses, you may be responsible for adjusting claims that fall within the SIR. You may hire a third-party administrator to perform this function. Alternatively, your insurer may adjust claims and bill you for the claims expenses.
  • A SIR may be subject to a Per Claim limit or an Each Occurrence limit. An annual aggregate limit may also apply. An aggregate limit protects your business if it incurs numerous claims during the policy period that are less than the SIR.
  •  You may be required by law to purchase an excess policy. For example, if you self-insured your workers compensation obligation, you may be obligated by state law to purchase an excess workers compensation policy.
  • A SIR offers several benefits. First, it can provide significant savings on insurance premiums. Secondly, you may have greater control over the claims adjustment process. You can decide which claims to settle. Thirdly, you will have an incentive to control losses since you will be paying many of them out-of-pocket. Fourthly, your cash flow may be improved. You'll pay losses as they occur rather than paying insurance premiums in advance. 

Article edited by Marianne Bonner

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